At the mercy of volatile refining margins. Being an oil refiner, SPC is greatly affected by swings in refining margins which arise from the interplay of demand and supply for crude oil and refined products. Margins can go into negative territory, as 4Q08 and previous oil shocks have shown. It is beyond SPC's control when that happens, and inventory write-downs have to be taken when crude oil prices fall drastically. However, assuming that oil prices will not fall much further given last year's dramatic drop, the likelihood of another extensive inventory write-down is low. Finally, with Singapore being a swing centre, refineries in Singapore may feel the effects of low product demand even more.
Upstream growth as a form of diversification. SPC ventured into upstream operations in 2000 and has three producing assets out of its portfolio of nine assets. Upstream production is a natural hedge against its exposure to downstream refining and marketing, and assuming that crude oil prices maintain above breakeven levels in this current dismal environment, this would ensure more steady and sustainable earnings for the group.
Initiate with HOLD. We initiate coverage on SPC with a HOLD recommendation and fair value estimate of S$2.45 using sum of the parts valuation. The refining business is valued using 8x FY09F PER, lower than the regional average considering the refinery's lower complexity rating and taking into account that earnings may be relatively more affected in swing-centre Singapore. The E&P business is valued using 7X FY09F PER, similar to the regional average. We will turn buyers of the stock around S$2.20, barring a sudden deterioration in economic environment. Any oil discoveries may be a potential share price catalyst, but the general outlook for the group and the industry is muted for now.
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